The Valuation of Public Projects: Risks, Cost of Financing and Cost of Capital Current

20 Pages Posted: 14 Sep 2013

See all articles by Marcel Boyer

Marcel Boyer

CIRANO, Université de Monréal

Eric Gravel

StatLog Consulting

Sandy William Mokbel

Center for Interuniversity Research and Analysis on Organization (CIRANO)

Date Written: September 12, 2013

Abstract

It is often said that the private sector is in a good position to manage project costs and meet deadlines, but not, generally, to fund or finance projects. The underlying argument runs as follows: because the interest rate on government borrowings (the government’s financing cost) is lower than what is available to the private sector, the cost of goods or services will necessarily be lower if it is funded by government. However, there is confusion between the cost of financing and the cost of capital (or discount rate) that stems from an analytical error in assessing the true cost of public funds. This is a subtle but important error that is widespread in both the public and private sectors as well as in academia.

This analytical illusion is due to the fact that a significant portion of the government’s cost of capital is unaccounted for or not recognized. This portion is the implicit option granted by taxpayers to their government to require additional funds in order to meet the commitments made to the lenders when a project does not meet the expected level of profitability.

Discounting at an essentially risk-free rate is often justified by “the virtually unlimited taxing power of the Crown” – the project appears risk-free to lenders, but is obviously not risk-free for taxpaying citizens.

The authors identify the implications for the evaluation of public investments and relevant public policies such as direct subsidies to businesses, government endorsements of corporate borrowings, the comparison of public sector versus private sector delivery of public projects and holding a portfolio of risky investments dedicated to the future repayment of the debt. It goes without saying that other evaluations of government policies and interventions could be similarly challenged.

Keywords: Governance and Public Institutions, Pensions, Infrastructure

JEL Classification: H43, H54, H81

Suggested Citation

Boyer, Marcel and Gravel, Eric and Mokbel, Sandy William, The Valuation of Public Projects: Risks, Cost of Financing and Cost of Capital Current (September 12, 2013). C.D. Howe Institute Commentary No. 388, Available at SSRN: https://ssrn.com/abstract=2325507 or http://dx.doi.org/10.2139/ssrn.2325507

Marcel Boyer (Contact Author)

CIRANO, Université de Monréal ( email )

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Montreal, Quebec H3A 2M8
Canada
514 985-4000 (Phone)
514-985-4039 (Fax)

HOME PAGE: http://www.cirano.qc.ca/~boyerm

Eric Gravel

StatLog Consulting ( email )

4673 Clara Brousseau
Québec City, Québec G1Y 3M9
Canada

Sandy William Mokbel

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

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